3. Deductible Expenses Notes

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3. Deductible Expenses Revision

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2. Expenditure on Repair and Improvements - Capital and Income Expenses

3. The "Wholly and Exclusively" Restriction on Deducting Income Expenses A. The Meaning of "For the Purposes of Trade" B. The Meaning of "Wholly and Exclusively" C. Summary of the Rules from the "Wholly and Exclusively" Cases

4. "Apportionment" of Expenditure A. The Pre-Statutory Case Law B. Apportionment under Statute

When spent monies are "deductible" for income tax and corporation tax purposes, any expenditure by the taxpayer in the accounting period of assessment can be deducted from the final taxable income or corporation tax bill. However, general expenditure must satisfy a two-fold test set out by Sections 33, 34 Income Tax (Trading and Other Income) Act (ITTOIA) 2005 and Sections 53, 54 Corporation Tax Act 2009 for unincorporated business income and corporate income respectively Firstly, the expenditure must not be of a "capital" nature, but must be "revenue" monies Secondly, the expenditure must be incurred "wholly and exclusively" for the purposes of the trade - and special rules apply under Section 34(2) ITTOIA/Section 54(2) CTA 2009 for apportioning the expenditure into deductible and non-deductible parts. In addition, there are special judicial considerations concerning expenditure on travel, and special further statutory provisions governing expenditure on business entertainment.

Section 34 ITTOIA 2005/Section 54 CTA 2009 - Expenses not Wholly and Exclusively for Trade "(1) In calculating the profits of a trade, no deduction is allowed for - (a) expenses not incurred wholly and exclusively for the purposes of the trade, or (b) losses not connected with or arising out of the trade (2) if an expense is incurred for more than one purpose, this section does not prohibit a deduction for any identifiable part of identifiable proportion of the expense which is incurred wholly & exclusively for the purpose of the trade"

1. No Deduction for Capital Expenses - Capital and Income Expenses
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Capital expenditure is not deductible in computing profits even though incurred wholly and exclusively for business purposes, as now enshrined in Section 33 ITTOIA/Section 53 CTA 09 The task of distinguishing revenue from capital expenditure is not easy, and the problem has been made difficult by the inevitable fact that words or formulae that have been found useful in one set of facts may not be useful in another, and no test is paramount In deciding such difficult questions the court's task is to determine the true profits of the business - but the court is hampered by the fact that a deductible expense must be entered when the expense is incurred and cannot be spread over a number of years

The taxpayer company constituted a pension scheme for employees, under which each member undertook to contribute 5% of his salary, and the company undertook to contribute an amount equal to one-half of the members (so a third of the total pot) The company also undertook to pay £31,784 to form the nucleus of the fund and to provide the capital necessary in order that past years of service of their existing staff should rank for pension. The House of Lords held, Lords Carson and Blanesborough dissenting, the expense was not deductible because it was expenditure once and for all with a view to bringing into existence an asset or advantage for the enduring benefit of the company's trade, and was therefore a capital expense not deductible from the profit-loss account

Viscount Cave LC
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In determining whether a particular item may or may not be deducted from profits, it is necessary first to inquire whether the deduction is 2

Corporate & Business Taxation (BCL)/Magister Juris (MJur)

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expressly prohibited by the Act, and then, if it is not so prohibited, to consider whether it is of such a nature that it is proper to be charged against incomings in a computation of the profits…
A sum of money expended, not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the grounds of commercial expediency, and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purposes of the trade The payment is clearly within that description: the payment was made for the sound commercial purpose of enabling the company to retain the services of existing and future members of staff It is clear that the £38k was not "capital withdrawn" from the trade, for it was not paid out of capital but out of the incomings of the year; nor was it (strictly speaking) a sum "employed or intended to be employed as capital in" the trade - it did not remain in the company's hands but was paid away to trustees Capital expenditure is usually something spent once and for all whereas income expenditure is more something that is going to recur every year While this is no doubt true, it is not decisive A payment can be "once and for all" but be properly chargeable against the income receipts for the year: thus a gratuity of £1500 paid to a reporter on his retirement has been rightly held to be an allowable deduction from profits But when an expenditure is made, not entirely once and for all but with a view to bringing into existence an asset or advantage for the enduring benefit of the trade, I think that there is a very good reason (in the absence of circumstances leading to the contrary) for treating such an expenditure as properly attributable not to revenue but to capital Thus money expended by a brewery with a view to acquiring new licensed premises, or expenditure incurred by a shipbuilding firm in deepening a channel in order to enable its vessels to be put out to sea have been held to be in the nature of capital expenditure and so not deductible under the Income Tax Acts The object and effect of the payment of this large sum was to enable the company to establish the pension fund and to offer to all its existing and future employees a sure provision for their old age, and so to obtain for the company the substantial and lasting advantage of being in a position to maintain an efficient staff I am thus satisfied that the payment was in the nature of capital expenditure

Comment

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One of the tests used by the courts was developed by Viscount Cave: even where expenditure is not made "once and for all", if it is to secure a permanent advantage or asset for the enduring benefit of the trade, then it will normally indicate capital expenditure The principal difficulty is that many types of expenditure have an enduring effect but not all of them are in the nature of capital; a payment to get rid of an unsatisfactory employee is a revenue expense but one to get rid of a lease is a capital expense This indicates that the true test is the nature of the asset acquired by virtue of the expenditure, and this seems to be the view taken in Tucker v Granada, considered below.

Lord Carson (dissenting)
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I can find no grounds for holding that the sum in question comes within either of the said categories [of capital or of income]…. It is clear from the terms of the trust deed that it would be eventually exhausted in payment of the pensions and that in the event of the winding up it could never form part of the assets of the company I cannot conceive of any system of commercial accountancy under which this sum would ever appear in the capital accounts of the company Nor, I think, can it be disputed that if any time the fund threatened to become insolvent after it was started a sum paid to prevent such insolvency would be a proper disbursement in arriving at the balance of the profits and gains I can find no reason for holding that a payment made to make up the contribution to a sufficient sum to enable the older servants of the company to enjoy the benefits of the pension fund brings into existence an asset or an advantage for the enduring benefit of trade and might therefore be attributed not to revenue but to capital

Comment
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According to Viscount Cave, the test does not concern either the nature of the asset in the hands of the taxpayer (i.e. to what use it is to be put), nor the identity of the account out of which the expenditure came; whereas Lord Carson took the view that these monies - which would form part of the distributable assets of the company in insolvency - would draw their capital nature (for tax purposes) from these two tests.

Heather v PE Consulting
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The shares in the company were owned 41% by the company's employees and 59% by outside shareholders; following drastic changes in the senior management by the outside shareholders, which upset the professional staff, a trust fund was set up by the company to purchase shares in the taxpayer company to be held by trustees for the benefit of the company's employees 4

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If the trust came to an end the fund was to be divided among the employees The commissioners found that the objects of the scheme were (a) to give staff an opportunity to purchase a stake in the taxpayer company and (b) to remove the possibility of outside interference with the business of the company

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The company claimed to deduct the annual payments into the fund for income tax purposes as being revenue expenditure constituting expenses wholly exclusively in the course of their trade, and therefore deductible, under the Income Tax Acts.

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The Court of Appeal held the payments to be deductible since the purpose of the scheme was to enable the company to carry on business more efficiently (for this depended on the high expertise of its staff) and that the expenditure was unpredictable and each annual payment on its own would not be enough to achieve the object of the scheme In doing so, his Lordship distinguished Atherton

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Lord Denning MR
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The question whether something is revenue expenditure or capital expenditure assumes that all expenditure can be put correctly into one category or the other; but this is simply not possible: some cases lie on the border and this border is not clear but undefined It is like the border between red and orange: everyone can tell the difference except in the marginal cases; but then everyone is in doubt Where no decision can be said to be right or wrong the safe rule is to go by precedent…
In British Insulated Cables v Atherton, a marginal case, different minds could (and did, in the House of Lords) come to different conclusions with equal propriety; there Viscount Cave for the majority summed up the situation, "when an expenditure is made to bring into existence an asset or an advantage for the enduring benefit of a trade, this is a good indication of… capital expenditure" I agree with the commissioners that this case does not fall within Atherton The purpose of these payments was to provide an incentive for the staff, to make them more contended and ready to remain in the service of the taxpayer - they were annual payments too - all of which makes them more like the annual payments in Atherton's rather than the nucleus fund
- they were all regarded by the taxpayer company as rewards to staff for the profits they had helped to make Although, unlike in Atherton's, one of the objects here was to remove the possibility of outside interference with the business of the company, this does not alter the nature of the payments as revenue expenditure 5

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Buckley LJ
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The payments here are different in several material respects from the sort of payment which was under consideration in Atherton's case; in the first place, whereas the payment in Atherton's was a single payment, we are here concerned with a series of payments being made annually under the covenant contained in the trust deeds Moreover, no one of these payments was in itself sufficient to achieve the object of the scheme incorporated in the trust deed The aggregate of those payments was unpredictable: the payments year to year were calculated by reference to the fair value for the time being of the shares in the taxpayer company, which might vary year to year Lord Wilberforce in IRC v Carron said that for expenditure to take on the character of capital expenditure, it was not necessary for it to produce any recognisable capital asset However, there must be something which can be pointed to as in the nature of a permanent advantage to the company if it is to be treated as expenditure on a capital asset But it will be one essentially of a revenue character in that it enabled the management and conduct of the company's business to be carried on more efficiently…
In the present case the objects of this scheme were to enable the taxpayer company's business to be carried on more efficiently; they were directed to improving and maintaining the trading potential of the taxpayer company and facilitating its trading to advantage

Comment
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Both Buckley LJ and Lord Denning MR went on to agree that the trial judge had placed too much emphasis on the expertise of accountants, and stressed that Odeon Associated Theatres had not made accountancy practice binding on the court - merely a factor to be taken into account; Lord Denning: "The courts have always been assisted greatly by the evidence of the accountants and their practice should be given due weight, but the courts have never regarded themselves as being bound by it and it would be wrong to do so." Of course, given the enactment of what are now Section 25 ITTOIA 2005 and Section 46 CTA 2009 (Cross-References notes on Trading Receipts/Corporate Profits), profits are now to be calculated in accordance with generally accepted accounting practice. Since expenditure of the sort in Heather v PE Consulting undoubtedly factors into what a business's profits are, the statutory provisions would now apply Nevertheless, the judiciary may still take the view that the proviso in those sections, that calculation in accordance with GAAP is "subject to any adjustment required or authorised by law," will cover judge-made law.

The Minister of Transport (the landlord) granted to a company a lease of a motorway service area for 50 years; the rent payable was in two elements, first by a fixed annual fee, and secondly by reference to the gross profits of the tenant taxpayer company The gross profits of the taxpayer took into account cigarette duties, which upon their rise had the effect of raising the second element of the lease rent and had the effect of reducing the taxpayer company's annual profits The parties renegotiated the lease: instead of paying off the additional cost by reference to gross profits every year, the taxpayer would pay a lump sum to cover six years of the rent on tobacco duty, which it duly did The taxpayer tried to deduct the payment in computing its taxable profits for the accounting period in 1974, since it was a payment made to get rid of an annual charge against revenue The House of Lords held that on the identifiable asset test (i.e. whether a capital asset had been acquired by the expenditure), the payment was to be treated as a once and for all expenditure on a capital asset (i.e. the lease) designed to make it more advantageous

Lord Wilberforce
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I think that the key to the present case is to be found in the cases which have sought to identify an asset: in them it seems reasonably logical to start with the assumption that the money spent on the acquisition of the asset should be regarded as a capital expenditure Extensions from this starting point are, first, to regard the money spend on getting rid of a disadvantageous capital asset as capital expenditure; and second, to regard money spent on improving the capital asset as capital expenditure. The test may be to some extent arbitrary, but it provides a means which the courts can understand or distinguishing capital and income expenditure and I think that we would be wise to maintain it. The present case is a case of once and for all expenditure on a capital asset designed to make it more advantageous; the lease was a valuable asset for the taxpayer's trade and so, if an asset, was a capital asset. It appears to me impossible to divorce the payment from the lease and to regard it as simply a payment intended to increase the appellant's share of the profits That it may have done, but the parties chose to do it through the medium of a lease

Comment

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